Luigi Zingales on Incentives and the Potential Capture of Economists by Special Interests

Luigi Zingales of the University of Chicago's Booth School of Business talks with EconTalk host Russ Roberts about Zingales's essay, "Preventing Economists' Capture." Zingales argues that just as regulators become swayed by the implicit incentives of dealing with industry executives, so too with economists who study business: supporting business interests can be financially and professionally rewarding. Zingales outlines the different ways that economists benefit from supporting business interests and ways that economists might work to prevent that influence or at least be aware of it.

Explore audio highlights, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Oct 20 2014 at 10:40am

Coleridge, who wrote op-eds for a decade around 1800, wrote in one that conflict of interest is the pulley on which good character is hoist into public view.

That still works.

(Essays on His Times, which is volume 3 of Coleridge Collected Works, Princeton. Look in the index under Pulley.)

Vengeful Ghost of Socrates
Oct 20 2014 at 1:57pm

“I can resist everything except temptation,” said Oscar Wilde.

I would like to highlight what we all already know, that economists are heavily captured by government institutions as well. In fact, it would be better to say that most economists are created in a prison of such captivity. Better still, that they love envisioning the benefits of clever and invisible chains on others, without noticing the tapestry of locks and links already in place before them.

Patrick R. Sullivan
Oct 20 2014 at 3:13pm

You devote a fair amount of time to the AIG-Goldman Sachs episode, Russ. As it happens Insurance Journal is doing a pretty good job covering the trial in DC in the U.S. Court of Federal Claims right now.

David Boies seems to be making a strong case that Goldman execs (along with the support of former Goldman men at Treasury, Hank Paulson and Ken Wilson) hand-picked a former Goldman man to be installed as CEO of AIG in September 2008. Then Goldman Sachs was the beneficiary of decisions made by that AIG CEO, Ed Liddy, to the tune of almost $13 billion.

The details, as related in the article, are pretty amazing.

Oct 20 2014 at 3:40pm

I am reminded of a few lines from a sci-fi novel, The Dosadi Experiment by Frank Herbert, on the selcetion of Jurists —

The interpretation of bias was: “If I can rule for a particular side I will do so.”

For prejudgment: “No matter what happens in the arena I will rule for a particular side.”

Bias was permitted, but not prejudgment.

Richard Fulmer
Oct 20 2014 at 4:35pm

Zingales seems to have his own set of blinders. He sees economists captured by industry but none captured by government.

Oct 20 2014 at 8:12pm

Contrarian Contrarian

I see academia more as a market. Clearly papers are indirectly being purchased. I have friends who have had research cancelled when they were not finding what their government sponsor wanted. The market aspect of research is a feature not a bug.

Being a contrarian is not supposed to be easy. In a functioning society we need people to implement the plans of others, and all (or even significant minority) independent thinkers has never been the case, especially in academia.

I consider myself a contrarian and a valuable resource to bring up different points of view, but there is not a social order that will embrace different ideas. It is not human nature.

No observers are truly impartial spectators, but with the challenge of having the bias of conventional wisdom stacked against you, when you do change a mind, it has a beauty that could not occur if contrarians were fully accepted without bias.

Oct 21 2014 at 12:05am

My thoughts were similar to those above who asked, What about capture by government? Don’t some economists get government grants? Are there none who wouldn’t look askance at a stint on the council of economic advisors, or at the Fed, as consultant to the Dept of Energy, or Commerce, or Labor, the IMF, World Bank, etc.? Don’t politicians hire economists to bolster their political positions? Money sluices through Washington agencies at the rate of billions a day–are there no economists interested in collecting a trickle here and there? If you’re an economist and you want publicity, do you think you’ll get more media play by saying markets are great or markets are flawed and the government needs to do something about it?

Case in point from another subject: where is there more grant money to be had to study global warming, from the EPA, DOE, the UN, etc., or from energy companies? Hint: most energy companies won’t touch the topic with a barge pole but research funding runs into the billions.

In short, Zingales is a wonderful economist but in this case he seemed curiously incurious about the other side of the ledger.

Oct 21 2014 at 4:51am

Really enjoyed this episode. Great guest. Great topic. Especially enjoyed the comment about the lack of competition in the economics journals.

Shawn Barnhart
Oct 21 2014 at 10:46pm

Vengeful Ghost of Socrates writes:
I would like to highlight what we all already know, that economists are heavily captured by government institutions as well.

I think the risk is that their opinions are for sale to any bidder. To borrow a commonly misattributed quote, we’ve already established what you are, now we’re just establishing the price, or in this case, the purchaser.

Being captured by government institutions is no worse than being captured by private industry.

I think as Russ pointed out later on in the show, it’s too easy to sell a economic opinion as a product without a lot of proof as to its veracity and the weight of the opinion has influence.

Oct 22 2014 at 9:56am

What percent of economists have worked for the Fed at some point in their careers? Perhaps that influences the direction of their work just a bit.

Oct 22 2014 at 11:29am

[Comment removed pending confirmation of email address and for name-calling. Email the to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.–Econlib Ed.]

Fred Smith
Oct 22 2014 at 12:46pm

I come from Louisiana – Zingales from Italy – both societies that don’t tolerate corruption, but rather insist upon it. That leads me from time to time to over-generalization – it certainly has led Zingales to that end. Capitalism fares poorly in corrupt societies with the result that crony wealth-redistribution policies dominate wealth creation. We both run the risk of over-generalizing from our background.

Crony societies have little to do with capitalism and neither do Zingales’s caricatures.

Capitalism does include some sinners and there are concerns that markets address inadequately. But to focus on sin ignores the virtues of capitalism. Moreover, focusing on “market failures” ignores both “government failures: and the ways in which government policies make it difficult for markets to resolve them (prohibiting property rights, for example, makes it difficult to protect wildlife).

The real problem with economists is that they favor quantitative methods; thus, they focus on the role of money in politics, rather than ideology, the role of Bootleggers while neglecting the role of Baptists. That bias feeds into the view that money rather than ideology dominates politics. Silly.

Zingales seems largely unaware of the power of NGOs, the entrepreneurial role of regulators, the prevalence of government failures, and the ineptitude of business in politics. Chicago economists are no longer Chicago economists.

Daniel Barkalow
Oct 22 2014 at 2:59pm

The US has fewer nuclear power plants than France, but the ones the US does have are much less safe than France’s. I think engineering regulators are more likely than other sorts of regulators to give the industries they regulate challenges, since engineers like challenges. And, if the regulators require lots of new safety features, the industry is forced to hire engineers to design systems with those features. If regulators are cozy with skilled labor in an industry, that’s different from regulators being cozy with management or finance in the industry (not necessarily better, but not the same). Also, nuclear regulators clearly have an interest in making sure there aren’t problems that outsiders can detect, which provides somewhat of a check on the impulse to let anyone do anything or simply trust insiders that things are safe. Of course, this is only relevant to industries which could be substituted or stopped entirely.

One thing to consider with respect to the CEO compensation/board membership question is that, since boards set CEOs’ pay, if you ask someone who’s on a board if CEOs are overpaid, you’re asking if they’re doing their job appropriately. Of course, they could say, “Other CEOs are overpaid, but the CEOs of companies where I’m on the board are not”, and that could even be true. Maybe responders who think most CEOs are overpaid actually pay their CEOs less. But there’s also the information bias the other way: if I’m on boards that really don’t overpay the CEO, I’m more likely to think that boards in general are like mine.

Cowboy Prof
Oct 27 2014 at 1:22pm

Great podcast. Zingales is always a good guest.

I was intrigued by a statement that Zingales made near the end of the interview. He claimed lobbying always used to be to “get government off one’s back” but nowadays it is to lobby for regulations.

I am not sure how far back “used to be” is. My class is reading Adam Smith’s Wealth of Nations and Smith has a classic quote in Book I.x.c. (paragraph 27). “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the publick [sic], or in some contrivance to raise prices. …But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.” (p. 145 of Liberty Fund’s 2 volume set).

Likewise, Bastiat’s famous “Petition of the Candlemakers” informs us that lobbying for more regulations is nothing new under the sun (solar reference intended).

About this week's guest: About ideas and people mentioned in this podcast episode:

Podcast Episode Highlights
0:33Intro. [Recording date: September 23, 2014.] Russ: He's the author of a very provocative and utterly fascinating piece, "Preventing Economists' Capture," that appeared as a chapter in a book on regulatory capture published last year, and his essay is the subject of today's episode. So, Luigi, welcome back to EconTalk. Guest: My pleasure. I love to be back. Russ: Now preventing economists' capture is not about kidnapping or abduction. Your piece is about the biases that economists bring to their research and their policy positions. I want to start as you do in the paper with the idea of regulatory capture in general, and how economists view the incentives facing regulators. Guest: Yes. I think it's very important to explain to ordinary people that when economists talk about regulatory capture, i.e., the fact that the regulators tend to design regulation more in favor of the industry that they regulate than in favor of the public that these [?] are supposed to protect, they don't imply that regulators are corrupt or lack integrity. Certainly [?] around the world there are examples of corrupt regulators. But I think in the United States by and large that's not the case. And on the one hand this is great news. On the other hand, this makes it more difficult to both understand and fight the kind of capture that economists talk about. So, let me try to explain what they mean. They mean that when you do your job, you tend to be affected, inevitably, almost psychologically, by the people who provide you the information, the people who follow you; and also, in addition to that, the people who can give you a job in the future. But even without going to the third element that maybe is the most [?] one if you want, let's start with the first two, that seems to be very benign. But they're quite important. As a regulator I need information about the industry. I need to know what the problems are. And the best source for these data are exactly the people I regulate. So, if I am too tough with the regulated, I end up not receiving the very information that is necessary for my business. The second aspect is, very few of us ordinary people follow what happens day in and day out in regulation. So, take the Environment Protection Agency (EPA). If I need to regulate some emission, most people don't pay attention to the exact level of emission. And short of a catastrophe, this decision will not be revealed[?] and discussed by ordinary citizens. On the other hand, the industry that is regulated will pay a great deal of attention to all the little details, because its profitability will depend massively by these regulatory decisions. And so the regulator will naturally pay more attention because the squeaky wheel gets the grease. And if I am a regulator and I am in doubt about what is the exact threshold for emission or whatever number you want to input in a regulation, there is always some uncertainty about what is the precise number. And what I do know is if I make a mistake in one direction, I'm immediately exposed and [?] by the industry. If I make a mistake in the other direction, chances are that nobody will find out. So, naturally, even without being a cynical bastard, I will inevitably tend to make mistakes only in one direction. And notice I've mentioned all these things without even entering what at least in the regulatory capture discussion is probably the most important aspect, which is my career incentives. If I'm a regulator, generally I don't get a lot of money doing the job I do. The moment I step down as a regulator and I go to work for the industry, I make much more money. And so it's really tempting for me not to burn my bridges with the industry, because if I'm considered the worst guy for the industry, chances are when I step down I will not receive a job. So, all these facts together make unbiased regulation very difficult to take place, even in the complete absence of any corruption, at least in the form in which we mean traditional corruption.
6:07Russ: So, that's a well-discussed phenomenon in the economic literature, the fact that regulators get co-opted, get captured, have incentives to not do their job. And this is part of a larger literature in public choice, that politicians and regulators don't necessarily, maybe even come close to serving the public interest. Whatever that is--a phrase I don't like, because it masks the complexity of our preferences. But put that to the side. So this is a common argument put forth by economists. You have the startling claim in your paper that maybe economists face the same incentives that regulators do, and maybe we're not so straightforward and honest. So, explain why your analysis--why economists might be subject to some of these pressures. Guest: So, I basically try to apply this same rule[?] that we apply to regulators, to ourselves. And there is no doubt that most regulators are honest people that try to do the greater good. And in spite of that, we economists think that they might fall prey of the industry they regulate for the reasons I just explained. So, I thought from the same premise; and most of my colleagues and myself are people that are really dedicated to research, the public good, fairly honest and decent people. But we might be captured in the same way, lots of ways in which regulators are captured. So, I pointed out three ways in which sort of regulators could be captured. The first one is information. And this is a bit the same thing for economists. A late colleague of mine used to say that if I am an entomologist, I don't have to socialize with bugs. If I'm a business professor, why should I socialize with business people? And this reflects the attitude of an older generation of academics that was quite far from the business world. Today, things are different. And I actually claim that even an entomologist, if they could socialize with bugs, they will happily do it. Because they get more insight about how bugs work and so on and so forth. So the point I am making here is that it is intrinsic to our profession, especially for people who do business economics and finance, to interact with-- Russ: To socialize with the bugs. Yeah. Guest: Exactly. And so we get some rub-off from the bugs. When you socialize with somebody, it's natural that you tend to take the view of the world and to be more sympathetic and so on and so forth. Russ: But you raised, I think the more insightful point in your paper is that you raised the question--you understand why we might socialize with the business people. But why do they socialize with us? Guest: I think that they find it useful to be able to shape our views. I think that especially should business people know how important is the reputation of what they do. And communication is now an important part of every business. And communication with the academic world is an important part of it. And so, they like to sponsor our conferences, to come to our meetings, and to say things. I always noticed that it was interesting because, there was this Western Finance Association, and the NYSE, the New York Stock Exchange, started to sponsor a breakfast as the Western Finance Association immediately after the 1987 crash. And NASDAQ (National Association of Securities Dealers Automated Quotations) started to sponsor another breakfast at the Association immediately about the scandal about alleged collusion on [?] on NASDAQ. So, it's interesting that these things don't happen just by accident. Business people see the value of influencing academia, and they play their game. And you cannot blame them to play the game: that's part of what profit maximization is about. Unfortunately or fortunately [?] don't do the same. So I think that we have to be careful. We have to be more aware than entomologists about that risk, because we are more exposed to that risk.
10:56Russ: I think you are right about those breakfasts. I don't think they were just worrying about whether economists were hungry. I think it was probably just a little bit maybe self-interested. I can't help but think of Adam Smith's beautiful quote from The Theory of Moral Sentiments when I hear about your applying this model of capture to economists. Here's what Smith said: "He is a bold surgeon, they say, whose hand does not tremble when he performs an operation upon his own person; and he is often equally bold who does not hesitate to pull off the mysterious veil of self-delusion, which covers from his view the deformities of his own conduct." So, you're suggesting that we have some of the same deformities that the regulators have. And before you make the case, I just want to take two incredible beautiful examples you use in the book of regulatory capture outside of economics, outside of the economics profession. The first is nuclear power in France, a speculation I had never heard before. Talk about your insight, someone's insight, into why France has so much nuclear power. Guest: Oh. It's very simple. If I am an engineer, especially a nuclear engineer, there are two things. One is I probably started this profession because I love this particular field. And so I am in love with all the creations[?] of the field, including nuclear power. The second, which is more like in the line of standard economic reasoning: once I became an expert in nuclear power, the value of my human capital is highly dependent on the success of the nuclear power industry. So, it's very unlikely that as a nuclear power expert I am going to start advocating against nuclear power. And even without thinking that I am literally bought up by the industry or people pay me to lie, I tend to view the world in a slightly different way. And it's not a coincidence, at least in my view, is that the country with the largest fraction of nuclear power is France, a country run by engineers, in the sense that the way to become part of the French elite is to go to the École Polytechnique and study engineering. And only the very top of the École Polytechnique make it to the French civil servants and into the administration. So, I think that if you have a country that is run by engineers, you are more likely to have a lot of nuclear plants. And if you are a country run by people with a degree in finance, you are going to think that every finance creation is great. Russ: That's a nice segue into the second example, which I just loved. I don't know if it's true--you don't have a source. But I assume you heard it from a horse's mouth. You say, "A revealing anecdote comes from a Bush Treasury official, who noted that in the heat of the financial crisis, every time there was a phone call from Manhattan's 212 area code, the message was the same: 'Buy the toxic assets.' Such uniformity of advice makes it difficult for even the most intelligent or well-meaning policymakers not to be influenced." So that's an example again where just the flow of information that came in to where the policymakers were was overwhelmingly pushed in one direction. Guest: Yes. First of all, I think that if you are Hank Paulson, you come from Goldman and you face a problem. You are likely to ask your friends, your trusted friends, for suggestions. And if your trusted friends are all in finance and they all bought a lot of bad mortgages, your trusted friends will probably push in one direction. And I think this is normal. I'm not saying that this is terrible. What is terrible is when there is not variety. One of my favorite sentences is the one that the late Prime Minister of France, Georges Clemenceau, once said, is that: The war is too serious a matter to let the generals run it. Russ: It's a deep truth. Guest: This is in some sense against specialization. But it is true that when you are overly specialized, you tend to miss the forest for the trees. And I think that if the administration is too much full of generals, they are going to do sort of a terrible war; sort of too full of finance people, they tend to come up with measures that are too much pro-finance. I think that that is just the nature of the beast. Russ: So, let's talk about economists. They are not regulating in the literal way the decisions made by industry. So, in what sense can economists be captured? What's the analogy between the regulatory capture example and what we do in our day-to-day research and policy advocacy? Guest: So, first of all, let's start with data. Nowadays it's very sexy and trendy to either use propriety data for certain analysis, or to do a field study about a certain topic. Now, the best researchers guarantee themselves against being prevented from publishing their results, the research they do. Still there is a very subtle quid pro quo about what I'm doing. So, if I partner with some payday loan, with one payday loan firm to do some field experiment, I probably don't want to come up with a result that says that payday loans-- Russ: Exploit poor people. Guest: Exactly. And so, it's not that I am sort of prevented from doing that. Like, the regulator is not prevented from really going after the industry. But the incentives are such that I probably will sort of fine tune and try not to look at the worst things, and look at the things I can look at. So, inevitably the research is going to be a bit biased. Now, we know every research is a bit biased. I don't think that anybody holds[?] the truth. But in general, we come to the conclusion that if we come across research, those individual biases cancel out, and as a result, the average is pretty accurate. What I'm saying is, because the data in this case are controlled by people with a particular interest, even if you take the integral of all this research, the overall picture cannot be unbiased. And again, it's not that any single piece is terrible. But when you analyze the overall research agenda or research result, you want to understand that this bias exists and try to undo it. And all too often, we tend to ignore that. Russ: So, that's one example. That's where people are beholden to the industry for data for analysis. And of course there are people who the industry trusts, because they know how their research is going to come out, and so they are happy to give that to them even when there are no strings attached. Because they know that person might even have a track record. So, you talk about this. That's one example. What are some of the others? Guest: Oh, another one is simply the success of your research. The success is not only given by how many other colleagues cite you, but indirectly also how popular your research becomes. Because if my research is portrayed in every newspaper, eventually this is going to trickle down to more citations. And I will become more important in my field as a result of that. So, I tend to have an incentive, especially early on in my career to establish myself, to come up with provocative statements that tend to be sort of more biased in favor of business. Why? Because the natural audiences, the ones that listen to me, are more business oriented. So, like every Secretary of Labor tends to be more biased in favor of labor, every sort of finance professor tends to be more biased in favor of finance and against labor. It's the nature of the audience. And again, it's not so terrible. Unless we don't recognize that and try to undo that at the aggregate level.
20:30Russ: And then, two other examples. You have editors. Talk about the publishing process--for those people who aren't used to the ugly kitchen of economic and scholarly research publication. We've talked about it a little on EconTalk in the past. But give us an idea of how the actual process works. You're an Assistant Professor, an example you talk about in the essay. And you send--what happens to you when you write a paper? Guest: Yeah. Let me start with this for your general audience. The life of a professor is great, except when you have to go through the process of submitting and receiving insults from your referees and trying to convince them that you have produced the best piece of work since sliced bread, and so on and so forth. And this process is not the same across different fields. In particular, in economics there are two features that are quite important for what I want to say. The first one is that it takes a long time to get a paper published. So, you submit a paper; and if you are lucky you receive a response in 4, 5, 6 months. Then of course you have to revise it; and then you resubmit. And then often you have two or three of these rounds. So, from the moment that you have a paper that you consider good enough to be submitted to the moment you have a paper accepted, let alone published but accepted is good enough for us, easily 2 or 2 and a half years go by. And the tenure track today, many academic departments, is 6 or 7 years. So, it is really critical for you to be fast and have these papers published. Now, what is interesting is you cannot submit two papers--the same paper--to two different journals. Russ: It's gauche. Guest: Legal scholars do that all the time. It's sort of accepted. In economics, this is abnormal. The way that you want to be expelled from the profession is to do that. And so, why do I think that's important? First of all, it is funny that economists who are so in favor of competition, they don't use competition in this particular case. Russ: Yeah. Yeah. Guest: And the second aspect is, suppose I am a young assistant professor; I submitted my paper. I got the first revise-and-resubmit. Then I got my second revise-and-resubmit. So, I am toward the end. This is an important journal. Publishing in this journal may make the difference between being promoted in a top university or having to look for a job and go down the pecking order of the academic department. Now, suppose the Editor asked me to omit a certain part of my paper because he thinks it's not interesting. Of course the Editor will never say 'I don't want this because this is bad for my business.' But will say, 'I want you to omit this part because it's [?] interesting or it's not well-documented; or, I would like you to skim the article in this particular way.' And very often the articles are not read for what is in it, but for the way they are sort of presented. I think it takes really a hero to resist this pressure, especially when you don't think that this is going to change dramatically the paper. And again, it doesn't change dramatically a paper; but if you can exert this pressure on a systematic basis, this might change a lot of outcomes. Russ: So, there are a handful of editors who are in this position, and have the opportunity to push or change a little bit or just reject an article by sending it to the referees that the Editor knows won't like them. That's a whole 'nother issue. Won't like the paper. But why would an Editor care? What's in it for the Editor? Guest: First of all, people tend to assume over the years a position, which is in part is a result of their studies, and there is nothing bad about it--we all have sort of our view of the world, and ideally these views of the world are a result of what we learn over the course of our sort of our life. But they are also inferenced[? informed?] by what they do. So, if they are expert witnesses in antitrust cases where they mostly take the side against the DOJ (Department of Justice), then they are more likely to sort of see as negative a paper that will point out the benefit of antitrust, the cost of excessive market concentration. And again, I'm not saying that they do it on purpose, because they get paid for it. It's more subtle. We all have our biases that are driven by a lot of things; and one of our biases might be this one. And, as I said before, if we are in a large--there are a lot of important publications and the biases go all sort of ways, when we take the average, they cancel out. But the moment the prestigious journals are few and the Editors are few and they tend to be more likely higher on one side rather than the other, in the antitrust case, then we potentially have a problem. Russ: And this is also an issue, you mentioned sitting on corporate boards. Do you think a lot of Editors sit on corporate boards, in economics? Guest: Not a lot. But some. For full disclosure, I want to be very clear. I am a Business School professor. I sit on a board. And occasionally I do expert witness. So, I'm not trying to sort of polarize[?] everybody. Russ: And I would just point out that on your web page you have a disclosure of potential conflicts of interest where you list, as far as I know, accurately I don't know, but you list some of the places-- Guest: Actually, I need to update it. It's a bit old. Russ: But still, I've never seen anyone do that before in economics. It happens in other fields. So that's very impressive. I like that. Guest: Yeah. No, I think that this is important. I think that the problem is--first of all, not to be aware. But second, again, if you are on a board, you tend to view the world from a particular perspective. And if you start saying that fields are overpaid, I think you are less likely to join a board. Russ: You think so? Guest: And less likely to remain on a board.
27:33Russ: So let's talk about that issue. The empirical evidence in this paper is on CEO (Chief Executive Officer) compensation. We just had Tomas Piketty on EconTalk, recently; and he is of the view that corporate governance is totally messed up. The board is, for the CEO, is just a bunch of cronies and friends who rubberstamp raises; and they can push the board around. An alternative view--and that view is widely held by many, many economists--there's an alternative which is: No, it's much more competitive than you think; CEO salaries are earned in a competitive marketplace more or less. Of course there are some exceptions but in general CEOs earn what they are paid. So, how did you go about studying whether there is a bias in the views that people have? Guest: So, what I did--this is not particularly deep. But what I did is the following. The Initiative on Global Markets (IGM) at the University of Chicago does a study of economists on a number of topics. And for a while I was actually part of the economists that were surveyed. And one of the questions at some point that I was asked was whether they thought that [?] were paid above their marginal productivity. And what is interesting is that these people not only state their opinion, but they state their opinion with their name attached. So you can go on the websites of the IGM and see exactly how they voted. So, I simply took this vote and I correlated, so their opinion, with whether they serve on the board or not. And I even took out my own name, so that the sample was not biased. And what I clearly show is that you are much more like likely to think that CEOs are paid above their marginal productivity, if you don't see them on the board. If you see them on the board, you don't think that way. And I don't know whether it is because people are selected in one way or another: so, if I have a very negative view, I am less likely to be invited. Or even I am less likely to join a board. I suspect that Thomas Piketty is not somebody that people will invite on a board. Actually, I would not invite him on a board--for different reasons. But I don't think that he is very likely to be invited to be sitting on a board. Maybe the board of a publicly owned firm in France. But not a business in America. And is less likely to be even wanted if asked. So, that's one part. The other is that once you are there, you tend to shape the view a bit. One of the things I find most puzzling is that one of the people answering this survey is a very famous economist who I actually wrote some models of a tournament, where naturally a CEO is paid more than his or her marginal productivity, because the compensation is a prize. Like, if you win the Ryder's Cup or whatever, a big tournament, you are paid more than your marginal productivity. Why? Because that prize motivates everybody along the hierarchy. Which is perfectly efficient. In spite of the fact that also, his papers, he says that he doesn't believe CEOs are paid above their marginal productivity. Which I find a bit funny. Russ: Well, but we know why he wrote that. There's a non-creepy way to understand that, which is he understood it to be a political question really and not a question about economic theory. And he doesn't think there's anything wrong with how CEOs are paid. But put that to the side. Guest: But, sorry, but wait a second. The purpose of that survey is to shed the economists' view into the real world: how economists think about that. So, if you give a political view, then why do we ask economists? Russ: Well, that's a separate question. But I guarantee you that many, many people on that survey answer those questions, whether you want to call it strategically--or they don't literally look at the wording of the question. Just like every survey. Just like people who answer surveys often have to interpret the words in a different way. But, I take your point. And I think it's a fabulous point: That there's a subtle--possibly a subtle bias--going on there. How big are the magnitudes of that finding? You found them to be statistically significant. Are the magnitudes--are they large? Is it 99% of the people who are on board, say it's a good idea? 99% of the people who aren't on board think they get paid more than their marginal product? Guest: No, I don't remember the exact magnitude. I don't think that huge. So, to be honest, it's very difficult to assess the magnitude. But to be fair, it's also difficult to assess the magnitude of regulatory capture. So, I'm not trying to say that it's absolute. I'm just saying that we're not very different from regulators. And so if economists think that regulators are so terrible, they at least should look at themselves in the mirror.
32:58Russ: So, I want to look at myself in the mirror. And this summer I did a number of interviews in Silicon Valley with venture capitalists and with entrepreneurs. And I find them extremely impressive. And I like what they are doing to change the world. And I suspect that my interviews this summer of those people were a little bit softer than they might otherwise have been because I have a certain respect and admiration for their skill. And you talk about this. You talk about how economists admire innovators and business leaders and that that might distort our judgment. How might that work? Guest: I think that is a fascination with a topic. And again, I want to be clear here. I do admire great [?] and venture capitalists. I think that many of them create a lot of value. But I think as a researcher we should be objective and realize that all of them create value, first of all; and second, when you are a marginal investor in this business you probably are losing your money, because the top venture capitalists reserve their investments for old clients. So, if I am a new client trying to enter into this world, I get left with the leftover. And those are not particularly good. So, I think that we need to be very careful not to lose our objectivity. And I think sometimes keeping some distance is important. And one of the trends that concerns me is that--which is a good trend for other reasons but it concerns me from a capture point of view--is that it used to be the case that a lot of research in economics was archival research. So, if you just look at data and you don't interact with the box, then you are not sort of captured by the box. The moment you start to do research that is more involved with the box, on the one hand, it is better because it is more related to the real world. On the other hand, it might be a bit too closely related to the real world. So, I think that this is the intrinsic tension, especially for business school professors like me, because even if you might argue that doctors might be biased--but doctors don't have by design that they have to interact with businessmen. Business professors, by design, need to sort of study business and to some extent interact with the box. So it's much more difficult for them to retain their objectivity than it is for any other kind of profession except maybe lawyers.
35:57Russ: So, we're going to talk in a second about some of the ways that you suggest we might fight against these biases, but before we do I want to ask you a broad question. You mention in there, one of the issues we did not talk about yet, but one of the issues you do talk about in the essay is that donations to a university and to various departments--not just in economics, by the way; you talk about economics and particularly business schools, which are always trying to raise money--but of course other departments as well, particularly in the sciences, medical school: there's an enormous amount of money flowing into the universities, and then an enormous amount of money flowing to academics, for consulting, for boardships, being a public figure--there are many, many ways that economists make money today compared to the past. And I think there's been a real transformation of university and academic life in many, many fields. Not all fields--French literature is still pretty quiet. But in many, many fields, in science--yeah, I like to mention Balzac whenever I can--and in economics and in business and in law, there's a lot more money flowing into this so-called non-profit institution compared to say, 50 years ago. You go back to, say, 1964, university life, academic life was about scholarship. And it was about teaching and it was about research. Now, to a large extent, there's a huge entrepreneurial element in both the university and in the scholar's life that was not there in many fields. And I think what you are identifying here is the down side of that. Guest: Yeah. As everything in economics, there is an up side and a down side. There's costs and benefits. I think that the money flowing into academia is very useful in many dimensions and has improved the quality of research, etc. So I don't think the solution is to stop that. But I think we should be aware that it might corrupt things in a very subtle way. Fortunately I was never in a situation where there was an compromise of academic integrity. I never witnessed anybody in any committee to say we should promote or not promote this person because the research has been good for fundraising or has been bad for fundraising. However, things are a bit more nuanced in the sense that if your research is very popular because it's being picked up by a lot of business newspapers, you are probably more likely to be tenured. And if your research is very criticized by the business world, you have a harder time to be promoted in a business school--not directly, but I think indirectly. Nobody will ever say, 'You did not help us raise money.' But, you see your colleague who has research that they present in a lot of business circles and get a lot of accolades that are treated better. People see that and learn. Russ: Of course, if you write an anti-business paper you might have a better chance of getting tenure in a different department: because one of the things that I think you underplay--although you allude to it, you don't ignore it--is the role of ideology. So, whether you are pro-business, anti-business, whether you are a pawn implicitly or explicitly of business because you have a chance to make money there, an equally important issue, I think, in economics, as EconTalk listeners know is that we all have an ideology. And it seems to me that empirical work in economics is extraordinarily predictable. It's not the fact that the person sits on a board and writes a pro-business paper. It's that if a person is a free marketer, they're going to find a free market result; and a person who is an interventionist is going to find an interventionist result. And that seems to me to be the most appalling--along with what you are identifying; it all goes together--the real problem at the heart of our profession. Guest: I agree with that. But I think that, paradoxically, what is the most difficult to find is somebody who is pro-market but not pro-business. There are a lot of people who have an anti-business ideology, and they probably get hired and promoted in anti-business groups and departments and so on and so forth. But if you are not an anti-business person, then the temptation of tilting things a bit in the direction of pro-business even if this is not necessarily pro-market, is quite strong. And so, my view is the area of conservative, pro-market economists tend to be particularly distorted in this respect, because ideologically is not on the other side of the world, so if on the margin you get a better life by not tilting very much your views, you are more likely to do it. Russ: Yeah. That's really depressing. Because, first of all, you are at the U. of Chicago, where Milton Friedman in the Economics Department would constantly say, I'm pro-market, not pro-business. And he would also point out that most businesses are anti-market. They are pro-market for everyone else except their industry, which always has a special exception. And I think the issue here is extremely important, because especially in your situation, if I may turn the dial around: it's a finance problem in particular. Because most people who are so-called free market are very uncomfortable criticizing financial institutions from a business school perspective. I don't--whether it's because I'm not in a business school I don't know or whether it's because I have a stronger ideology. But when I say things like, well, the financial sector tends to influence policy in a really corrupt and unhealthy way, people say to me, 'Well, but how can you be so critical of them? They are just doing what's in their natural self-interest.' And I'm saying, 'Yeah, that's in their natural self-interest; that's what's wrong with it.' And their natural self-interest in to influence regulation. We should be trying to stop it, not saying, 'Well, can you blame them?' And then to blame the politicians for trying to stop that. That's bizarre. Guest: Yeah. I think it is bizarre. And I think it is a leftover from a time where every form of lobbying was lobbying to get the government off your back; which as free marketeers we all in favor of. Now a lot of the lobbying has become how to get the government in your pocket. And I think that that is the big change a lot of people on the more Conservative side of the political spectrum have not fully appreciated. I think that that's an important thing to understand. Russ: I totally agree with that.
43:10Russ: So, let's move to some of your suggestions for what might improve the quality of economists' honesty and integrity. One of them is shame. So, what role might shame play? So, I think that there is a lot of peer pressure in the academic community. And so, you are not going to write a paper that says outrageous things or not-well-justified things, because you are kept in check by your colleagues. [?] when we move outside of an academic environment and we do expert witnesses or other advice, this is less the case. It's true that expert witnesses, another side that charges you. But it's not always another academic; it's a different environment. And most importantly, unless you go up to the final trial, you never get exposed in what you say. Russ: You can say some really bad things, and no one will find out except the lawyers. Guest: Exactly. So, one of my proposals, which is very simple, is to say, 'Why don't we pass regulation after 2, 3, 5 years, a reasonable amount of time, every opinion given in a trial is fully disclosed? Then, people, academics will be much more careful in what they say because they are biased to be shamed by their colleagues. Russ: Now, the problem with this--two examples came to mind when I read this. One is--well, let me read your quote and then I'll give the other example. You say, very nicely,
An economist who always opposes government intervention, then makes an exception when the government bails out a certain industry where he has a direct interest where he has a direct interest could be easily exposed to the public ridicule.
And I find it fascinating--I think about Alan Greenspan, when I read this. Alan Greenspan for some reason has a reputation as being a hard-core free market person. I think that reputation comes from the fact that he was friends with Ayn Rand, who was a hard-core free market person. But once Alan Greenspan was Chair of the Fed, he wasn't much of a free marketer. In particular, he always, as far as I can tell--and that's my bias, and maybe there are some exceptions--but he often at least would support government regulation pro-subsidies to the financial sector and violate his so-called free market principles. So, my favorite example is the 1995 Mexican Rescue, where he said, testified in front of Congress, 'This is a terrible idea, to guarantee Mexican loans, but we have to do it.' And of course, one reason we had to do it was because a lot of the people who profited from those loans and who would lose a lot of money if Mexico couldn't continue to borrow, was the financial sector, which Alan Greenspan was, of course, at the top of. Those are the people he chatted with, as you point out; those are the people he interacted with; those were those 2-on-2 phone calls that said a lot of things but probably involved being nice to the financial sector. So it's interesting that we did not ridicule him sufficiently at the time. I don't think he got much ridicule. In fact, he was probably honored for being pragmatic. And I think economists should have spoken out against that. The second example I want to give is from the essay. You say--I got a kick out of it for a variety of reasons. You say,
For example, in years past, many famous economists wrote papers commissioned by Fannie Mae and Freddie Mac. In some of these papers they were going as far as saying that "This analysis shows that, based on historical data, the probability of a shock as severe as embodied in the risk-based capital standard is substantially less than one in 500,000--and may be smaller than one in three million." Still, the authors do not seem to have suffered any consequence of these wrong statements. In fact, one of these authors was promoted director of the Office of Management and Budget and later hired as Vice Chairman of Global Banking at Citigroup.
And that was Mr. Orszag. One of the other authors of course was Joseph Stiglitz. Now, to defend them--and I don't trot this example out when we are talking about the financial crisis, because you could defend them by saying 'Well, they weren't really talking about this kind of risk, the kind of risk we ended up with. It was a different kind of risk.' But the fact is, they took money; they wrote a paper on behalf of Fannie and Freddie; they didn't get a lot of ridicule for it. They did from you and me--maybe--from people like us. But in general, part of the problem is, who really wants to get Joseph Stiglitz mad at him? I don't mind so much--he's already been a guest on EconTalk, so I could say something negative about him--and again, I'm trying to be fair to him. I don't think he wrote a horrible paper. I think he wrote a paper that helped Fannie Mae and Freddie Mac. I don't think he's totally wrong in his prediction even though it turned out to be the case that it was very risky. But the point is, who wants to get them mad at you? Who wants to get Peter Orszag mad at you? These are influential people who can affect your career. So the problem just gets pushed off a little bit, I think, even though the shaming thing has potential. Guest: Yeah. And I do say in my essay that shaming very important people might have some return. We see that for example CNN (Cable News Network) has a program called "Keeping Them Honest" where they check the facts and see if the politicians, to what extent they lie or misrepresent the facts in [?]. But I don't think that economists are so sexy[?] that there was a CNN program or something like that. I think this was one of those things that should have been done by NGOs (Non-profit Government Agencies), because I think that economists--academic economists are very sensitive to their reputation. And I think that having some form of discipline will have an impact. Russ: What about changes to the publication process? I found those very interesting. What would you recommend? Guest: I think that I would like to see more competition in the market, because young assistant professors will be less captured by the editor. And also would I think to be useful to have editors not play particular role while editors. I think that there is a funny attitude, even in Finance, where we seem to be ashamed to pay our editors. I think that being an editor is an awful job and needs to be highly compensated. If you do a good job and as a result should compensate you enough that you have no time and no interest in doing anything else, rather than teaching and being an editor. And I think that this should continue even for a couple of years after you step down as an editor. I think that I'm very happy to pay more for that, but having that independence, I think, is important. Russ: Of course, we could do the same thing on the regulatory side. We could pay regulators a lot more so that the revolving door was not as attractive to walk through, and have them turn to industry. I guess that that's not happening. Guest: Absolutely. Absolutely; but the funny thing is: I understand that in the public sector money is more scarce and that also the mentality is that you don't want to pay people a lot. But the funny thing is that even in the finance profession, where a lot of professors say you should reward CEOs a lot, etc., when it comes to rewarding a lot the Editor of the Journal of Finance, they [?] objections. Russ: Are you an Editor of the Journal of Finance, Luigi? Guest: No, never. Russ: Have you been one? Guest: Full disclosure. Russ: Do you hope to be one? Guest: I don't hope to be one. I am in this moment the professional[?] of the American Science Association. And I think that currently we do pay our editors. But in the past this was a battle, because a lot of people were resisting it.
51:30Russ: So, last--one of the things you talk about is awareness. Which some might say is naive, but I do like it. I'm a big fan of awareness. So, what's your argument there? Guest: I think it's not a perfect solution, but definitely it's a first step in the right direction. Without that step it is impossible to achieve any result. And what I find is funny is that even this step is so difficult to do. I had a lot of people rejecting completely, totally, my argument, saying this doesn't apply to them. And to me, it is-- Russ: It's the best, isn't it? Isn't that the best? That just proves the point. That's what's so beautiful about that. I've heard that from guests on EconTalk. I'm not going to name them. But, you know, they say, 'Of course I'm not biased. I can separate my ideology from my research. And similarly, Paul Krugman--who, by the way, people ask me: 'When is he going to be a guest on EconTalk?' And my answer is, 'Whenever he'd like.' I've invited him before. He may not have received the emails. He's a busy man. But I'd love to have him on. But, having said that, he, in response to something I wrote once, said, where I confessed that I had an ideology and maybe I was biased, he said he does not. He's only a truth-seeker. And this is a man whose blog is called "The Conscience of a Liberal." So, it's interesting that he sees himself--we all have a tendency to see ourselves as these pure truth-seekers. We have a lot of romance about our profession, about our careers, and about ourselves. And when somebody says, 'Yeah, that's a great point but it doesn't apply to me,' it's hard to know what to say except to laugh. Guest: Yeah. Absolutely. You said it perfectly. On the other hand, there are people who do have this awareness. I was very impressed a few years ago when I went to the European Central Bank, and I was talking with one of their top-level persons, who was dealing with the market every day. And he had this view that if the ECB (European Central Bank) did not intervene to save Greece, there will be a disaster. So I asked him point blank, because I can be pretty obnoxious sometimes: so I asked him, sort of 'Don't you think that the fact that you deal with the market every day affects your views?' And he was-- Russ: Towards? Guest: I was impressed. Because he said, 'I'm well aware of this. I try every day to undo this bias. Whether I succeed or not remains to be seen.' So chapeau[?French, hat tip, respect--Econlib Ed.] to this person. I think--so the chapeau to this person. And that's what we should all try to do. I think that, as you said, people who don't even consider the possibility we'd be biased probably are the ones who are the most biased. Russ: Yeah. Although in the case of your friend at the ECB, I think the real challenge there is: What do you do about that, if you have that awareness? And one of the things you do is you try to listen to some other voices. Which is one of your points, right? You look for a little diversity. You don't just call 2-on-2. You mentioned Henry Paulson and talking to his friends in the financial sector--he talked to Lloyd Blankfein 24 times, I think, in the week or two weeks before the AIG bailout. I wonder how many other people he talked to. But that's--my joke is that they didn't talk about how their kids were doing. They probably talked about how the world needed to be saved by making sure AIG paid out all the money that it had promised, even though one of its clients, just coincidentally, was Goldman Sachs, that Lloyd Blankfein was the Chair of and that Hank Paulson was the former Chair of. So, it seems to me that one of the implications of awareness has to be getting a wider set of information. But the other point, it seems to me, is to invoke Adam Smith's impartial spectator. Not an imaginary one as Smith invokes, but a real one. Find somebody who is not connected to the industry, who isn't always hearing that Greece has to be bailed out or the world will come to an end. And see what they think. And I think that's extremely hard to do for people in those positions because of the incentives. Guest: Yes. But I think this is suggesting something important also in [?], that we need diversity, not so much in terms of gender--also in terms of gender but not only in terms of gender; also in terms of backgrounds, in terms of view of the world, in terms of the circles, and so on and so forth. I always tell my students that if you want to be a contrarian, you have to live in Omaha, Nebraska. You cannot live in New York or Connecticut and be a contrarian. Russ: Yeah. If you want to be invited to the cocktail parties that matter, you better be thinking like everybody else.
56:28Russ: Last question: I was going to ask you about reactions from colleagues, but I think you've already given me an idea of that. Although you are welcome to say something about--there may be a few who have said, 'Wow, that's really scary.' Does anybody like your paper? Guest: Yeah, some people like the paper. But I have to say that the most fascinating reaction is, I presented this a few years ago here in Cambridge, Massachusetts, and there was a group of people from Harvard Business School (HBS), and a group of academic economists. And these people from Harvard Business School were more like case studiers--they were not truly academics. And in the paper I make some examples about research and some examples about Harvard business cases, where the capture tends to be quite sort of obvious. And what was interesting was the Harvard, HBS, guys, were saying, 'Oh, the case idea is completely wrong, but we think that's true for the academic economists.' And of course the academic economists were saying that they could see that for the HBS cases but of course not for their research. Russ: Yeah. I think I could have predicted that. But it's still depressing to find that prediction to be accurate. Let me close then, with this. These are fascinating issues. I think they are really important. But isn't the underlying problem the fact that when we say something stupid, or something that is inaccurate, it's very difficult to hold our feet to the fire? Because economics is very, very difficult to pin down? So I make a prediction: Say, hypothetically, I say that we spend, oh, $800 billion in increased government spending during a recession; it's going to create so many jobs. Now, that turns out, that prediction was wrong. It just turned out to be wrong. But of course there's a story to tell afterwards, why it was wrong: It doesn't really mean I didn't understand it; I didn't really appreciate the size of this variable. Or whatever. And there's plenty of examples on the free market side, the most obvious being inflation. So, some of us on the free market side predict inflation; when it doesn't happen, we have a story to tell: All the money is tied up in the banks; why we didn't think of that in advance, I don't know. But that--we have stories to tell. Since there's always story-telling going on, it seems to me it's very difficult to hold economists accountable for what they say. And therefore these type of biases can persist. And that raises--you can agree or disagree with that. And then I want you to answer the tougher question, which is: Given that our pronouncements cannot be verified in any, often, real way, why are we so influential? So that's my closing question. Answer it any way you'd like, Luigi. Guest: I think that the reason why we are so influential is because the decisions that are related to us are so damn important. I think that we, to some extent, underinvest studying economics because the benefit of avoiding a Great Depression is so large that any reasonable amount of money spent in trying to study how to avoid it is well spent. So, I think that, not that--we don't necessarily spend it well; I don't want to be self-serving here--but I think that the stakes are incredibly high. And so, it's a bit like why a lot of chartists in Wall Street are so influential, is because you can make so much money if you have any predictive power in Wall Street that even if people don't, people try. So, I think that's the simple answer to the second question. The first question: what can I say? I don't know. I think that in academic department when you have intense family discussions, you can tell when people are sort of without a good argument or not. I think that there is not enough scrutiny in the public domain. There is a lot of, sometimes, fight; but not serious scrutiny. So, it's true: We cannot predict things with a high degree of accuracy. But I think that if people change their view depending on what is convenient and especially in issues that have more to do with microeconomics than macro, I think we can tell things apart much better.

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